Is the rise of SaaS stocks set to continue?

Software as a service (SaaS) stocks have remained resilient in the face of extreme economic turbulence, with SaaS share prices seemingly weathering the storm. Can they continue to deliver returns in 2020?

Software as a service (SaaS) stocks have proven to be a resilient sub-category of the technology market, particularly as the global economy struggles to defend itself against the Coronavirus pandemic.

While the Dow Jones Industrial Average [DJI] dropped 8.3% in the week beginning 16 March, the Nasdaq Composite [IXIC] felt less of an impact, dropping by 6.9%. Meanwhile, the BVP Nasdaq Emerging Cloud Index [EMCLOUD] actually saw an uplift, rising 9.7% over the same period.

The following week, the Invesco Dynamic Software ETF [PSJ] saw its share price rise 9.4%, while the iShares Expanded Tech-Software Sector ETF [IGV] grew 9% over the same period. Furthermore, during such a climate, analysts suggest that these sorts of companies can capitalise as businesses around the globe consider how to operate within the confines of the remote-working environment. So, is the rise of SaaS stocks set to continue in 2020?

How SaaS stocks fare in the face of volatility

“More businesses than ever are looking for online solutions to their problems right now and SaaS businesses are in an ideal spot to provide those solutions,” Todd Dickerson, co-founder of SaaS marketing and sales platform ClickFunnels, tells Opto. “SaaS businesses, by definition, have more reliable recurring revenue channels than most others.”

This is reflected in stock performance. SaaS stocks have carried their good run at the end of last year into 2020, with SaaS and cloud stocks surging to all-time highs. They have typically posted some of the strongest revenue growth results in the software sector.

While SaaS is not quite the same as cloud services, the terms are used relatively interchangeably, and their performance at least can certainly be gauged using similar methods, with many SaaS businesses appearing among the Emerging Cloud Index’s constituents, for example. Cloud computing is the remote infrastructure used to host data and applications, while the term SaaS refers to applications run on the cloud which can be accessed remotely by customers who usually pay a subscription fee.

Unsurprisingly, these upstart companies have also been involved in recent high-profile mergers and acquisitions — such as Salesforce’s [CRM] $1.35bn acquisition of mobile workforce management platform ClickSoftware — as big tech brands look to capitalise in a somewhat fertile market.

Headwinds blowing against the cloud

The SaaS industry does face challenges, however. It can be difficult to effectively predict long-term performance. These companies often re-invest heavily in themselves, which changes their outlook. Then there is inevitable pandemic related challenges.

Earlier this month, SaaS stocks fell victim to the ripple effect seen across the global economy as COVID-19 continued to spread and the market shifted from bull to bear. On 9 March, the BVP Nasdaq Emerging Cloud Index was down by 8.3%, closing at $1,134.51, its lowest level since October 2019. SaaS companies such as Atlassian [TEAM] were down by 7.9% and Slack [WORK] by 6.13%.

Furthermore, at close on 27 March, the PSJ had dropped to close down 2.31%, while the IGV was down 3.98%.

Despite this, there’s still an air of positivity around SaaS stock projections.

“While some tangential consulting and event revenue has decreased since the start of the pandemic, our overall user base has grown. We’re doubling down and finding more creative ways to deliver as much value as possible,” Dickerson explains.

“While some tangential consulting and event revenue has decreased since the start of the pandemic, our overall user base has grown. We’re doubling down and finding more creative ways to deliver as much value as possible” - Todd Dickerson

The big names in SaaS

Salesforce [CRM] is regarded as a pioneer of the SaaS movement. Founded in 1999, by current chairman and CEO Marc Benioff, it continues to dominate the market to this day. Amazon [AMZN] also has a large presence in the SaaS sector, with its Amazon Web Services unit launched in 2002.

In February, Salesforce reported full-year results, announcing $17.1bn in revenue. For the fourth quarter, it generated $4.85bn, up 34% year-on-year.

This follows several years of acquisitions which have raised questions around Salesforce’s ability to grow organically. However, new acquisitions like data visualisation platform Tableau Software are expected to enhance the analytics capabilities of Salesforce’s platform.

However, Salesforce is working with narrow margins: a 0.74% profit margin, 2.94% operating margin and a 0.73% return on assets (TTM). With tight competition from the likes of Microsoft [MSFT] and Adobe [ADBE] — the latter of which has seen share gains of more than 340% over the past five years — the need to outperform is constant.

Salesforce’s results also came with a surprise announcement — the departure of co-CEO Keith Block, after just 18 months on the job. On February 25th, the day the news was announced, sent shares down 2.6% in after-hours trading.

Up and coming

The space has also seen market debuts from relatively new competitors, such as Okta [OKTA] and Twilio [TWLO], which floated in 2017 and 2016, respectively.

IT consultant Gartner strongly endorsed Okta back in 2019 as part of its Magic Quadrant analysis, pitching the company ahead of the likes of Microsoft and IBM. This is unsurprising given Okta’s continued impressive growth. In its Q4 report, it announced 45% year-on-year revenue growth and a 30% year-on-year growth in customer numbers. Since its IPO, its stock has risen by near 400%.

Twilio has seen similarly blistering growth rates — with a 62% year-on-year revenue growth in Q4 and a dollar-based net expansion rate of 124%.

62%

Twilio's year-on-year revenue growth in Q4

More broadly, Gartner analysts shared fresh predictions with Opto. They anticipate SaaS growth to outstrip other sub-sector growth in cloud services in the next couple of years, anticipating SaaS to bring in over $148bn of the projected $350bn revenue forecast for the worldwide public cloud services sector — a whopping 42% of the total.

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